Toby Birch

Articles:

Hope for the best, plan for the worst

By Toby Birch April 2008 Hedge Fund Journal

Oscar Wilde's phrase the triumph of hope over experience could be applied to investors who assume that equities will always be sound in the long-term. Anyone with an eye for financial history knows that stock markets can stagnate and drift for decades at a time, especially when inflation is in the ascendant. Such episodes can also be tough for hedge funds as massive outflows were witnessed under similar conditions in the late 1960's.

So why should one plan for bad times and black swans? Great investors of the past have prepared themselves by wallowing in the worst case scenario as a dress-rehearsal of what could go wrong. Those who make no plans will be buffeted by unexpected events and will inevitably join the ranks of the consensus hoard. Until recently we assumed that quant risk modelling would cover the bases but Value at Risk may be a suspect measure of our vulnerability. When planning for possible economic problems one should
contemplate their cause, effect and potential consequences.

Cause: post-9/11 stimulation and tax cuts, too much money created from too much debt

Effect: inflation and debasement followed by deflation

Consequence: property and equity slump, power shift from West to East

Causal Credit
The author John Gardner once wrote, history never looks like history when you are
living through it. The TMT crash of 2000 should have been the pre-cursor to a major recession which over time would have brought the economy back into balance. Sadly, the terrorist attacks of 2001 made a recession politically unacceptable and America was goaded into a state of artificial economic stimulation. We are now paying the price for what may prove to be the biggest bet in financial history in the form of a credit crisis. This term is really a misnomer as what we face is a debt crisis, which undisciplined
developing countries endure; only that sort of thing is not meant to happen to smart westerners like us.

We should take a hard look at our own numbers. The US current account deficit could be confused with that of a banana republic. This can be funded as long as developing countries currencies remain dollar-pegged and commodities are dollar-denominated. These assumptions may well have a shelf-life. Reserve currency status is a privilege of military might and a dominant trade status. As America's influence diminishes, its steady
depreciation coupled with asset freezing orders is undermining the dollar's desirability - for the very people who subsidise their tax and interest rate cuts. We can now appreciate the foresight of the Founding Fathers who wrote America's Constitution in the same year as the French Revolution. Their currency was backed by precious metals to avoid economic turmoil.

Page: 1, 2, 3